Dividends are king

What’s the single main purpose of any business? It must be profit? What’s the best way of measuring profit? That must be cash paid back to shareholders, dividends?

Now sure there are a lot of other moving parts in any business and they’re important. But my first port of call with any set of results I am looking at is the dividend, simply I want to see it moving higher.

In my ideal world results will show increased revenue with earnings (HEPS) increasing at a higher rate and dividend at a still higher rate. For example; revenue +10%, HEPS +15% and dividend +20%. That shows me a business firing on all cylinders and achieving its core function of making profits for the shareholders.

What I also look at when first investigating a stock for my portfolio is the dividend cover policy. This is the amount of profits that the company pays out as dividends. Some stocks will have a cover as low as say 1.5x, in other words a 150c HEPS will see a 100c dividend. Others may be less aggressive and have a 3x cover (paying 50c of that 150c HEPS as dividend). More mature stocks with lower growth potential will likely have a lower dividend cover, but I don’t mind so much what the dividend cover policy is. Rather I want to see what it is and how it has changed over time. As the company grows and matures we should see the dividend cover reducing slowly.

A last point or two. Cyclical stocks such as miners will have boom or bust and as such the dividend will at times disappear. This is the nature of cyclical stocks and one of the reasons why I consider them more trading them long-term buy and hold stocks. That trading period may be years and needn’t be geared, but ultimately they will see profits and dividends collapsing and I don’t want to be holding during that period.

Small cap stocks also require a different approach. They may well be making profits but they could be putting all the profits back into the company to grow the business. Here I am happy to hold small and midcap stocks but I don’t consider them long-term investments until they have proved themselves and are issuing strong and growing dividends.

I hold CoreShares DivTrax ETF. I like the Core Shares/ S&P Div Aristocrat approach which is based on selecting stocks with a 5 year track record of good and stable/growing dividends (not % yield). Would you agree that this could be thought of as a momentum investing approach, based on your points above? In light of this, I am a bit puzzled as to why the ETF has basically gone nowhere in the last year.

Any thoughts?

Wayne

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